H OW TO E VA LUAT E

PR I VAT E R E A L ES TAT E
I N V ES T M EN TS

A GUIDE FOR
ACCREDITED
INVESTORS
 I N TROD UC T I ON

Don’t fall in love with an asset, the saying goes — a reminder that real estate
investment properties aren’t possessions to collect at any price but, rather,
need to make financial sense. Beautiful properties don’t always make great real
estate investments, just as ugly properties don’t always make bad real estate
investments. It’s easy to let intuition get in the way of making sound decisions,
with glossy brochures that highlight charming properties, but yet rarely offer
investors the true picture of what they’re getting into. It’s important to fall in
love with the investment returns, but not the asset itself.

Real estate investing is a complex business. When evaluating opportunities,

investors have to make informed decisions largely based on assumed future
forecasts. It’s critical for investors to differentiate between opportunities with
businesses plans that may easily succeed versus others where the stars have to
align perfectly to succeed.

This guide will help the accredited investor move beyond brochures and conduct
a due diligence process that gives them confidence in the asset manager’s
business plan and assures alignment with their personal investment goals. It will
also help investors understand the types of risk managers encounter in private
real estate, the most common forecasting metrics, and the fees managers
collect during the complex, multiyear investing process.

TA B LE OF CONTENTS

3 Evaluating Real Estate Risk 18 Private Real Estate Investment Fees

9 Understanding Investment Returns 22 About Origin Investments and the Author

13 What to Look for in a Manager

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EVALUATING
RE AL ES TATE RISK
We all know real estate values rise and fall. But
how likely is a move in either direction, and by
how much? More significantly, is the expected
performance of the investment worth the risk?
The larger the risk, the larger reward one should
expect. But the reverse is also true: high risk
means there is a greater chance of failure.

For that reason, if one portfolio manager returns

20% on a real estate investment but takes twice
as much risk as a manager who returns 15%, the
smaller return is actually better on a risk-adjusted
basis. That’s because the fund earning 15% is
taking half the risk, so the investment is more
likely to offer downside protection and will have
less variance around its forecasted returns. Every
real estate investment should be evaluated based
on its own risk-reward profile.

Here are eight risk factors investors should

consider when evaluating any private real
estate investment:

1. GENERAL MARKET RISK

All investments have ups and downs that are tied

to the economy, such as interest rates, inflation
or other market trends. Investors can’t eliminate
market shocks, but they can reduce the volatility
of their portfolio by diversifying across a wide
array of investments, including stocks, bonds,
public REIT’s and private real estate. A balance of
public and private real estate investments helps
effectively diversify across geography and sectors
and effectively manage liquidity.

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2 . A S S E T- L E V E L R I S K
In real estate investing, there are different risks
associated with each type of property. For
instance, there’s always demand for apartments
in good and bad economies, so multifamily real
estate is considered a low-risk investment. But
for that reason, apartment buildings often yield
lower returns. Office buildings are less sensitive
to consumer demand than shopping malls, while
hotels, with the reliance on seasonal tourism and
business travel, pose far more risk than either
multifamily or office investments.
3 . I D I O S Y N C R AT I C R I S K
Some risks are specific to the asset and the
asset’s business plan, which makes them
particular to a certain situation — or idiosyncratic.
Every individual deal is subject to idiosyncratic
risks. Construction, for example, will add risk to a
project because it limits the capacity for collecting
rents during this time. And when developing a
property from the ground up, investors take on
more types of risk than just the construction risk.
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They can also encounter entitlement risk, the
chance that government agencies with jurisdiction
over a project won’t issue the required approvals
to allow the project to proceed; environmental
risks that range from soil contamination to
pollution; budget overruns and more, such as
political and workforce risks.
Location is another idiosyncratic risk factor.
For example, buildings behind Chicago’s Wrigley
Field used for private rooftop parties went
from boom to bust investments when a new
scoreboard completely obliterated their views,
while property values near The 606, Chicago’s
version of the New York’s High Line, are rising.
A seemingly safe and passive investment is
also subject to idiosyncratic risk. Tenant credit
can change quickly and can make or break an
investment opportunity. Tenant bankruptcy
examples have become commonplace in the
retail real estate sector, for example, as brick
and mortar stores have been decimated by the
competition of internet commerce.
How to Evaluate Private Real Estate Investments 4
4. LIQUIDITY RISK

When an investor isn’t able to sell a property

quickly, liquidity risk may be at fault. An investor
can expect dozens of buyers to show up at the
bidding table in a place like Houston, regardless of
market conditions. However, a property located in
Evansville, Indiana will not have nearly the same
number of market participants, making it easy to
get into the investment, but difficult to get out
of it. The strategy for selling a property needs to
be determined when entering into a real estate
investment. Smaller markets may be fine for
investors planning to hold the property forever,
but not for assets with a finite business plan or
the investor who may need their capital back at
a moment’s notice.

5. CREDIT RISK

The length and stability of the property’s income

stream is what drives value. There is always a risk
that something could happen to the property’s
income stream. A property leased to Apple for
30 years will command a much higher price than
a multi-tenant office building with similar rents.
However, even the most creditworthy tenants
can go bankrupt. Remember when landlords
were happy to have Sears and J.C. Penney
anchor their malls?

The huge market in so-called triple-net leases,

which are often said to be as safe as U.S.
treasury bonds and require tenants to pay taxes,
insurance and improvements, can fool property
investors. The more stability in a property’s
income stream, the more investors are willing
to pay because it behaves more like a bond with
predictable income. However, the triple-net lease
landlord is taking a risk that the tenant will stay
in business for the length of the lease, and that
there will be a waiting buyer.

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 6. REPL ACEMENT COST RISK 7. L E V E R A G E R I S K

As demand for space in the market drives lease
rates higher in older properties, it’s only a matter
of time before those lease rates justify new
construction and increase supply risk. What if
a new building makes the investment property
obsolete because there’s a better facility with
comparable rents? It may not be possible for
an investor to raise rents, or even attain decent
occupancy rates. Evaluating this situation calls for
understanding a property’s replacement cost to
know if it’s economically feasible for a new building
to come along and steal away those tenants.
To figure out replacement cost, investors should
consider a property’s asset class, location and sub-
market in that location. This helps investors know if
rent can rise high enough to make new construction
viable. For instance, if a 20-year-old apartment
building is able to lease apartments at a rate that
would justify new construction, competition may
very well come along in the form of newly built
offerings. It may not be possible to raise rents or
maintain occupancy in the older building.
The more leverage (debt) on an investment, the
more risky it is and the more investors should
demand in return. Leverage is a force multiplier:
It can move a project along quickly and increase
returns if things are going well, but if a project’s
loans are under stress — typically when its
return on assets isn’t enough to cover interest
payments — investors tend to lose a lot quickly.
So in general, investments that are capitalized
with more debt should project a higher return on
equity investment.
In example A below, we illustrate the difference in
return on equity when using 85% debt versus 70%.
The project financed with 85% debt requires only
$3 million of equity and generates a total return
on equity of 121%, while the project financed
with 70% debt requires $6 million of equity and
generates a total return of 65%.

E X A M PL E A : D E B T ’ S I M PAC T O N
EQUITY IN A POSITIVE MARKET
85% LEVERAGE 70% LEVERAGE

Cost $20,000,000 $20,000,000

Equity $3,000,000 $6,000,000

Debt $17,000,000 $14,000,000

Sell amount (proceeds) $25,000,000 $25,000,000

Accrued interest at 4% over 2 year hold $1,360,000 $1,120,000

(we’ll ignore amortization for the sake of simplicity)

Gain/loss on equity investment $3,640,000 $3,880,000

Total return on equity 121% 65%

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 However, looking at example B, you can see how
debt works both ways and how quickly the returns
can change in a down market. If the market were
to decline by just 5%, investors using 85% leverage
would lose 79% of their invested capital, while
investors who levered at 70% would lose only 35%.
As a rule, leverage should not exceed 75%,
including mezzanine and preferred equity.
Returns should be generated primarily from the
performance of the real estate — not through
excessive use of leverage. Highly levered projects
shouldn’t necessarily be avoided altogether;
investors just need to make sure they receive
a return commensurate with the risk.
Unfortunately, there is no set rule or scale that
dictates the exact incremental return one should
expect to receive for one higher leveraged
investment over another. The great equalizer
when comparing investment opportunities to one
another is to look at them on an unlevered basis.
Generally, the one with the higher unlevered
return is going to provide the better risk-adjusted
return once debt is applied, assuming all of the
inputs are realistic.

E X A M P L E B : D E B T ’ S I M PAC T O N
EQUIT Y WITH A 5% MARKET DECLINE
85% LEVERAGE 70% LEVERAGE

Cost $20,000,000 $20,000,000

Equity $3,000,000 $6,000,000

Debt $17,000,000 $14,000,000

Sell amount (proceeds) $19,000,000 $19,000,000

Accrued interest at 4% over 2 year hold $1,360,000 $1,120,000

(we’ll ignore amortization for the sake of simplicity)

Gain/loss on equity investment ($2,360,000) ($2,120,000)

Total return on equity -79% -35%

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 8. STRUCTURAL RISK

This has nothing to do with the structure of

a building; it relates to the investment’s
financial structure and the rights it provides
individual participants. A joint venture is when
multiple operators come together to own one
investment property, and this is where structural
risk comes into play.

In joint ventures, investors must be aware of

their legal and profit sharing rights, which are
spelled out in the operating agreement of the
partnership. The operating agreement will detail
how much of the compensation they will have to
pay the manager of the LLC throughout ownership
and when a property is sold.

If an investor is a limited partner, the gross

profits will be diluted by the compensation
that’s paid to the LLC managers. The terms in
the operating agreement will help the investor
understand how much of the profits they will
receive if the deal is successful.

The operating agreement also details the specific

requirements to remove a manager, should the
situation arise. Partnerships always start with
good intentions and a good partner is invaluable.
On the flipside, nothing is worse than having a
bad partner who doesn’t know what they
are doing, who behaves unethically, or is
undercapitalized. The terms should outline
the standards for manager removal and what
percentage of limited partners it takes to remove
them. It’s important to look for a manager who
is also heavily invested in the deal, is well-
capitalized so they are on equal footing with the
limited partners and are well-compensated when
the deal succeeds.

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UNDERS TANDING
INVES TMENT RETURNS
There are two metrics real estate managers use
most often to describe their return on investment:
the equity multiple and the internal rate of return
(IRR). The educated real estate investor needs to
use both equity multiple and IRR to evaluate and
compare investment returns.
The equity multiple reflects the amount of
money an investor earns by the end of a deal
and is expressed in terms relative to the original
investment dollars. For example, if an investor
puts $1 million into a property and eventually
gets back $2 million, the multiple is 2x. Knowing
the multiple on equity shows an investment’s
true impact on wealth.
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IRR describes the time-weighted compounded
annual percentage rate every dollar earns during
the time it is invested. It accounts for the value of
money over a certain period of time. The easiest
way to calculate IRR is to plug an investment’s
cash flows into Microsoft Excel and use the
“=IRR” function.
IRR has inherent limitations that are explored in
more depth later in this guide, but the biggest
challenge with IRR is that it doesn’t quantify
the amount of wealth the investment created.
Generating a 17% IRR over five years sounds
great, but not if it generates only a 1.3x multiple
on invested equity.
You can’t spend IRR.
How to Evaluate Private Real Estate Investments 9
 CO M PA R I N G I N V ES T M E N T R E T U R N S
An annualized total return is the average amount
of money earned by a real estate investment
each year. Many investors mistakenly compare
IRR to the annualized return to make investment
decisions, which can be a costly mistake. Private
equity real estate investors can find many
impressive IRRs available on short-term deals.
But investors must pay close attention to the
time period it took to achieve the IRR and the real
wealth that was created by using IRR in context
with the multiple on invested equity.
For example, a 30% IRR over three months works
out to a total return of only 7.5%. However, real
estate is not a liquid investment. Its true potential
and return on investment is not in short-term
profits, but in holding for the long term. It’s better
to have the investor’s capital generate a 12%
annualized return over three years than an 18%
IRR over three months.
Chasing high IRR with investments that have
short durations is one of the biggest mistakes
investors make. Before an investor commits to
a private real estate investment, they should
evaluate the manager’s past IRR track record
E X A M P L E C : T W O $1 0 0 K I N V E S T M E N T S , B O T H G E N E R AT I N G A 1 5 % I R R
Initial investment
SCENARIO #1
Year one cash flow
Year two cash flow
Year three cash flow
Total gain on equity
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against the equity multiple track record to
determine how much actual wealth the manager
created for investors.
In example C below, we look at two $100,000
investment scenarios. In both, investors had their
money tied up for three years, but the investor
in the second scenario made far more than the
other, despite both scenarios generating a 15%
IRR. The first scenario produced a 28.5% total
gain on equity, as compared to a 52% total gain
on equity in the second scenario. In scenario one,
the investor would have needed to immediately
invest any cash flow they received into other
investments. However, it’s impossible to predict
what investments will be available in the future
and it takes time, energy and discipline to find a
suitable place to reinvest distributions.
To be fair to the concept of IRR, getting money
back sooner rather than later helps reduce risk.
Cash flows that happen far out in the future
are generally riskier than cash flows that are
expected to occur earlier. And, cash flow would
presumably be invested into other investments at
the time it is received.
($100,000) Initial investment ($100,000)
SCENARIO #2
+ $50,000 Year one cash flow + $0
+ $50,000 Year two cash flow + $0
+ $28,500 Year three cash flow + $152,000
$28,500 Total gain on equity $52,000
How to Evaluate Private Real Estate Investments 10
WAT C H : O R I G I N C O - F O U N D E R D I S C U S S E S I R R V S . E Q U I T Y M U LT I P L E

“ If I said to you, ‘I’m going

to get you a 2 multiple
on your money,’ you
could actually spend
that... And if I tell
you ‘I can get you a
30 IRR,’ that doesn’t
even mean anything.”

DAVID SCHERER, Origin Principal

H O W I R R C A N B E M A N I P U L AT E D

IRR is calculated using dollars that flow to and
from investors. The shorter duration between
contributions and distributions, the higher
the IRR. IRR is susceptible to manipulation by
managers because they have the ability to
influence the timing of cash flows. This makes it
difficult to tell the difference between managers
who create value and managers who financially
engineer returns.
The most common abuse in manufacturing IRR
amongst fund managers involves the use of a
subscription line, which is a credit facility provided
by a bank that is collateralized against investor
commitments. Fund managers use subscription
lines to close on deals quickly and manage
cash flow. The bank knows the fund manager
can always call capital from investors to pay
down the line, which is why they are willing to
extend them affordable credit. Subscription lines
generally mature at the same time the fund’s
investment period ends, which can be three to five
years after the fund’s final close.
A manager can manipulate IRR by funding deals
directly through the subscription line and then
holding the deal there for as long as possible
instead of calling capital from investors. A
manager can delay calling capital for years with
a flexible subscription line. This greatly enhances
the investment’s official IRR at the expense of the
investor, who sits on their capital commitment
and pays fees while the manager loads up the
subscription line with deals. Even worse, managers
typically receive higher incentive fees for higher
IRRs, so a manager could use the investor’s
balance sheet to obtain cheap capital in order to
make more fees.

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 In example D, we show how a manager can easily
manipulate IRR. In both scenarios, the investor
commits $100,000 and all deals are acquired
in the first year. In the first scenario, instead
of using the subscription line, all of the capital
is called from investors, resulting in an IRR of
14%. In the second scenario, the manager uses
a subscription line to fund the deals instead of
calling capital from investors until the second
year, resulting in an IRR of 30%.
Private real estate managers need to be evaluated
not only on their ability to produce IRR, but also on
their ability to invest capital in a reasonable time
period. Reviewing a manager’s historical track
record is the best indicator of how a manager
produces IRR. Though past returns may not be
indicative of future returns, a manager who has a
history of manipulating IRR will undoubtedly use
the same trick again in the future.

E X A M P L E D : T W O $1 0 0 , 0 0 0 I N V E S T M E N T S R E S U LT I N G I N D I F F E R E N T I R R S

SCENARIO #2
SCENARIO #1

Year one ($100,000) Year one* $0

Year two $0 Year two ($100,000)

Year three $130,000 Year three $130,000

IRR 14% IRR 30%

*Subscription line used to fund deals

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WHAT TO LOOK FOR
IN A MANAGER
Projecting real estate returns is an inexact science.
There are hundreds of assumptions that go into
building a financial model, and every input is
at the discretion of the investment manager.
Every private real estate investment starts with
a promise of high returns. Some will exceed
projections while others will fall short, and many
will actually lose money. So the challenge for
private real estate investors is trying to figure
out which opportunities will meet or exceed
expectations, and which ones will become a
“learning” experience.

In real estate investing, it’s more about who one

invests with than what they invest in. It’s the
manager who decides what price to pay for an
asset, how to build value, the appropriate capital
structure, how to course correct when things go
wrong and when to exit. A good manager will be
realistic and thoughtful about the assumptions.
Finding a real estate manager who will behave
reasonably and responsibly is paramount to
success in this industry.

Asking the right questions of a manager during

the due diligence phase is critical. Only then is
it possible to understand if their investment
strategy aligns with an investor’s personal risk
profile. Think of it as a job interview, and the
investor is hiring the manager to be a good
steward of their capital and a good partner.
Unfortunately, too many deals get funded with
nothing more than great marketing materials.
And there are many unqualified investment
professionals in today’s market passing
themselves off as experts.

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Here are ten questions that investors should ask
to get a telling picture of a real estate manager’s
approach, ethics and potential performance — and
what to look for in their answers to identify the
best managers. But keep this caveat in mind: just
because a manager may not meet every criteria
on this list, it doesn’t mean they should be written
off. It’s key to listen for cues in their answers that
shed light on their honesty and integrity.

1 . H OW H AV E YO U R PA S T D E A L S
PERFORMED?

Track records are hard to fake. Evaluating

a manager’s past successes or failures is a
great measuring stick for how well the current
opportunity will turn out. It’s important to gauge
if they have delivered consistent returns across
all of their deals. A manager who has produced
a 15% IRR over the last ten years without losing
any money is far different than a manager who
produced 15% IRRs, but gained money half the
time and lost money the other half. Additionally,
if the manager suggests that their new fund will
generate 30% returns, but they’ve never generated
30% returns before, there is a low likelihood that
they will actually meet their projections.
Good managers don’t lure investors with
the expectations of high returns. They set
realistic expectations and strive to meet those
expectations in bad times and outperform them
in good times. Real estate investing is not a get
rich quick scheme where investors should be
taking high risk.
not transactional fees. “ Skin in the game” ensures
the manager is motivated by the right outcome.
Managers should win when their investors win,
and lose when their investors lose.
3 . H OW IS YO U R T E A M I N CE N T I V I Z E D?
It takes a team to see an asset through —
from acquisition to sale. Making sure the team
is aligned through performance is critical.
Investors should ask the manager if their
team is incentivized based on transactions or
performance. Additionally, ask how they retain key
team members and what their retention rate is.
Conflicts of interest are prevalent in this industry
and minimizing them is important. One way

2 . HOW M UCH OF YOU R OWN MON E Y
ARE YOU INVES TING?
Alignment is everything. The manager should
be investing a significant amount of his or her
own capital (capital not funded by others) right
along with the investors. And the bulk of his or her
earnings should come from investment returns —
to do so is by making sure that the team is
compensated based on performance and not
on transactions. Also, investors should make
sure that the team that is in place today is the
same one that was responsible for delivering the
manager’s historical returns.

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4 . W H AT I S YO U R C O M P E T I T I V E
A D VA N TA G E I N T H E M A R K E T ?
It’s important to know what the manager
believes his or her team does better than
anyone else in the marketplace. This competitive
advantage is generally something quantifiable.
For example, if they say their competitive
advantage is in sourcing opportunities, then ask
how many deals they look at before they pick the
best ones, and ask where they find their deals. If
their competitive advantage is in operations, then
they should be able to benchmark themselves
against an industry standard.
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5 . H O W D O YO U C O M M U N I C AT E T O
YOU R INVES TORS?
Communication is paramount to a successful
relationship. Timely and accurate reporting is
one of the most important elements of a good
manager because there is nothing worse than
being in the dark. Investors should ask for sample
reports from their latest deals and play close
attention to the dates to make sure they are
delivered quarterly. Take note of what the reports
cover and if the manager updates investors about
both good and bad news. The end investment
performance is what matters most, but a
manager who communicates poorly can cause
some sleepless nights and a lot of frustration.
6 . ARE TH E ASSU MP TIONS IN YOU R
FINANCIAL MODEL REALISTIC?
Projections are only as good as the inputs and
every one of the inputs is at the discretion of
the manager. No real estate manager is 100%
accurate in their business plan assumptions.
What is important is that the manager conducts
a stress test of each input into their financial
model, which means quantifying what under-
performance on each input will do to the expected
investment outcome. The basis of protecting
downside and limiting losses is in understanding
how an investment will perform if and when
things don’t go the expected way.
One of the best ways to learn about a manager’s
approach is by inquiring about the assumptions
they use in their model and asking what the deal
looks like when their assumptions are taken to the
extreme. Sometimes small tweaks to one or two
variables, such as the growth rate or cap rate,
can vastly impact returns.
How to Evaluate Private Real Estate Investments 15
The next input to note is net operating income.
Good managers create value by increasing net
operating income, which is impacted most by
occupancy and rental rates. Look at their assumed
growth rate of revenue and their occupancy
assumptions. Every deal has an occupancy
assumption at stabilization. Make sure the
property is in line with the rest of the market,
or slightly below it.
Investors should also understand how the
manager treats expenses. Expenses will increase,
so it’s important to ensure the manager applies
a realistic inflation rate to all costs associated
with executing the business plan. Property tax
increases, for example, can have a big impact
on the bottom line, so make sure the manager is
resetting them based on the new purchase price
and not using historical figures. Also, ensure the
manager takes into account a rising interest rate
market and a rising cap rate environment in the
underwriting. Every model should account for
higher interest rates.
Be sure that you know how much leverage the
manager uses with each deal. As we discussed
earlier in the guide, used responsibly, leverage
can enhance returns. But beware of deals that
are financially engineered with mezzanine debt
and preferred equity. Ask if the manager cross
collateralizes assets. Cross-collateralization of
assets is when one asset is used to guarantee the
debt on another asset. In a fund structure, assets
should not be cross-collateralized because it
destroys diversification and magnifies risk.
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This practice played a large part in why private
real estate investors lost so much money during
the financial crisis and is very prevalent in real
estate debt funds, so investors must read the
fine print. Also, understand if they personally
guarantee loans, because doing so can be
catastrophic for a manager and the investors if
that loan gets called.
Most importantly, be familiar with their business
plan and if it seems realistic, as most plans fail
because they are ill-conceived from day one. Use
a common-sense approach; for example,
a Class A property can’t also be home to low-
income renters. A business plan should be easy
to understand and make sense intuitively.
7. W H AT W A S Y O U R W O R S T D E A L
A N D W H AT D I D YO U L E A R N F R O M I T ?
Every manager has multiple bad deals in their
past. Investors should actually want a manager
who has been in the trenches and has some
battle scars to prove it. A good manager will
be forthright about their mistakes, what they
leaned, and how those deals helped shape the
firm’s investment philosophy. It’s the job of the
investor to decide if these are one-off isolated
events and if the manager is being sincere versus
if there is a history of pursuing risky deals with
ill-conceived business plans. It’s important to
understand if the manager communicated to
investors during any down periods. How they
treated the investor during a down period is an
indicator of their integrity.
How to Evaluate Private Real Estate Investments 16
8 . CAN I SPE AK WITH ON E OF YOU R
CURRENT INVESTORS?

Investors should also ask to speak with one of

their current investors or a former investor. Ask
about their experience and if they recommend the
manager. A really creative investor could also get in
touch with one of their former employees through
LinkedIn and ask them about the company.

9. H OW I S YO U R CO M PA N Y F U N D E D ?

It’s important to determine whether or not the

company has ample cash flow to pay the bills
or if they’ll need to lean on their investors for
additional capital. Assess if there any risk that
they will go out of business by looking at their
balance sheet. Avoid managers who operate on
shoestring budgets or are just starting out. When
considering investing in a fund, it may be better to and value and low fee real estate deals can end
wait until Fund II or III, after the kinks have been up being very expensive. The quality of a business
worked out. Regardless, experience matters and plan and the asset manager who runs it make the
it’s important to invest with an experienced and most impact on the success of a project. Fees are
well-financed team. a function of the complexity of a business plan
and should be correlated to the value the manager

1 0 . W H AT I S I N C L U D E D I N Y O U R F E E S ? is able to create. There isn’t necessarily a set

Another important part of vetting a manager is
understanding the fees they charge. Real estate
investing requires a dedicated team of people
to be successful and transaction fees help pay
for that team. Someone must find the property,
negotiate the price, create marketing materials
and legal documents, raise equity, manage the
day-to-day operations at the property, formulate
and execute the business plan, report to investors,
provide K-1’s, sell the asset and distribute the
proceeds. A great team does not come cheap, and
fees help managers attract and retain high-
quality employees.
Unlike the public markets, real estate is not a
business where you want to base a decision on
fees alone. There is a big difference between price
market rate fee, but there is a range that is fair.
Investors should be sure to ask about every fee
throughout the structure because sometimes fees
are buried in other LLCs below the investment
entity. Fees should be outlined in the Sources and
Uses of Capital section of the marketing materials
or the Private Placement Memorandum and this
is a must-read when evaluating any investment
opportunity. Ask the manager what their fees are
and how they are structured.
In the end, fees should guide — not drive — an
investor’s decision about whom to invest with.
What matters most is the return on investment
after all fees are considered and if that is an
appropriate return for the level of risk. We’ll cover
more about fees in the following section.

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PRIVATE RE AL ES TATE
INVES TMENT FEES
When vetting investment opportunities, look for a
fee structure that is largely performance-based, so
the manager wins when the investor wins. There is
a difference between fees that are used to create
investment value and exorbitant fees that simply
make the managers of private equity real estate
funds wealthy at the expense of their partners.

There are two main types of fees in real estate

investment management: transaction fees and
performance-based fees.

R E A L E S TAT E T R A N S AC T I O N F E E S

Transaction fees are guaranteed. The manager

gets paid these fees regardless of how the
deal performs. Below are the most common
transactional fees.

Acquisition Fee: This fee is most common

amongst managers syndicating individual deals.
The acquisition fee is usually between 1% and 2%
of the total deal size and is generally on a sliding
scale. The bigger the deal, the lower the fee. This
is a market rate fee and is justified because the
manager probably looked at 50 deals to find this
one. The manager already paid all of the dead deal
and personnel costs out of their own pocket.

Also, words matter in legal documents. Acquisition

fees are paid on the total deal size, as opposed
to equity invested. This is a significant difference
because a 1% acquisition fee on a $30 million
property comes out to $300,000. Most properties
are typically leveraged using two-thirds debt,
so the required equity may only be $10 million,
meaning that $300,000 fee equates to a 3% cost
of equity invested.

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Committed Capital Fee: This fee is typically
charged by called capital real estate funds and
ranges from 1% and 2% on committed equity.
The manager receives this fee even if the capital
is not invested. If a committed capital fee is
charged, an acquisition fee should not also
be collected, as this is what the industry calls
“double-dipping.” Unfortunately, many managers
try to get away with double-dipping when serving
individual investors.
Investment Management Fee: This fee is charged
by both funds and managers sponsoring individual
deals and is sometimes referred to as the Asset
Management Fee. For real estate funds, this
fee replaces the committed capital fee once
the capital is invested so that investors are not
being charged on the same capital twice. The
commitment fee is reduced proportionally as
money becomes invested. This fee ranges between
1% and 2% of invested equity and is used to pay
for investment management services. Again,
terminology matters, so this fee should be a
function of invested equity and not total deal size.
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Set up and Organizational Fee: Both real estate
funds and managers of individual deals incur set
up costs. These are typically passed through to
the investment entity and paid by all investors.
One-time upfront costs include legal, marketing,
technology, investor relations, and other costs
associated with capital raising and forming the
investment company. This fee is typically between
.5% and 2% of total equity.
For individual deals, these are generally not a line
item easily identified in the marketing materials
and are often costs that are lumped into the
property’s acquisition cost. Investors should be
aware of this line item and ask the manager to
explain the terms in specific detail to know exactly
what this fee is being used for.
Administrative Fee: These fees cover tax
reporting, audits, fund administration and third-
party software. They typically range between
.10% and .20% per year on invested equity.
How to Evaluate Private Real Estate Investments 19
OTHER TRANSACTION FEES TO LOOK OUT FOR INCLUDE:

Debt Placement Fee: This is a fee that is often paid to an outside broker, which is standard industry practice for lining up
debt. The typical fee between .25% and .75% of total debt, depending on deal size. A good broker can save a project a lot
more than the cost of this fee. However, some managers try to layer on their own internal fee on top of a debt placement
fee to the tune of between .25% and .75%. This is very impactful to equity, as the amount of debt used in a typical
transaction is two times larger than the amount of equity.

Refinancing Fee: This is similar to a debt placement fee and some managers charge between .25% and 1% for this service.

Wholesale Marketing Fee: This fee is typically paid to the broker dealer by non-traded REITs for product distribution and
equates to roughly 3% on equity.

Advisor/Syndication Fee: Some real estate companies such as private REIT’s use broker-dealers to distribute their
products through an advisory network. These advisors are typically paid an upfront, one-time fee of between 4% and 7%.
Some sponsors will charge a smaller upfront fee but add acquisition or transaction charges. Often these commissions are
hidden in the fine print that itemizes capital spending.

Joint Venture Fees: By themselves, joint ventures don’t add another layer of fees, but the investor is then paying two
managers instead of one. If the investment manager is simply providing access, then those fees should be much lower
than a manager who adds value to the joint venture by executing the business plan.

Selling Fees: It’s always good practice to take a project to market to generate the highest value. Typically, brokers are
paid between 1% and 3% of sales price, depending on project size. Some managers charge their own internal fee between
.25% and .75% on top of that.

While this may seem like a lot of fees, a good

manager will limit what fees they charge and
how much. Transaction fees are meant to keep
the lights on but not be a profit center for the
company. While we don’t believe fees should guide
a decision, they can tell you something about
the manager. A manager trying to extract every
last penny out of the deal through guaranteed
transaction fees is a clear sign that they don’t
have the investor’s interests in mind.
R E A L E S TAT E P E R F O R M A N C E F E E S
Performance fees are variable, based on the
success of the real estate investment. They
are common in nearly every private equity
investment — even beyond real estate — and
are used to align the interests of the manager
with those of the investor. The typical
performance/incentive fee entitles the manager
to between 20% and 30% of profits.

An investment waterfall is a method used in a real

estate investment to split the cash profits among
the manager and the investor to follow an uneven
distribution. In most waterfalls, the manager
receives a disproportionate amount of the total
profits relative to their investment. For example,
a manager may only put in 5% of the investment
capital but be entitled to 20% of the profits.

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Performance fees are usually subject to what is
called a preferred return hurdle, which is the rate
of return tier (usually as defined by a certain IRR
or equity multiple) that must be met before the
manager begins to participate in the profits. These
tiers are what define the various profit splits. The
preferred return typically ranges from between 7%
and 10% annually and can be viewed as an interest
rate on investor capital, but it’s not guaranteed.
There are two common types of waterfall
structures used in both real estate funds and
individual deals – European and American. In
a European waterfall, 100% of all investment
cash flow is paid to investors in proportion to the
amount of capital invested until the investors
receive their preferred return, plus 100% of
invested capital. Once these distributions have
been paid out, then the manager’s portion of
the profits increase. This is the most common
waterfall used in real estate fund structures.
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In the American waterfall, the manager is
entitled to receive a performance fee prior to
investors receiving 100% of their capital back,
but usually after receiving their preferred return.
To protect investors, there is usually a caveat in
the documents that states the manager is only
entitled to take this fee so long as the manager
reasonably expects the fund or deal to generate
a return in excess of the preferred return. It’s not
uncommon for income products that have longer
hold periods to be structured with this type of
waterfall or deals with hold periods that are
longer than 10 years.
Waterfall structures can impact investment
behavior and investors should make sure the
manager is motivated by the investment return.
Investors should make sure that if the investment
doesn’t perform as planned, the manager doesn’t
take a performance fee. Getting into a structure
where everyone’s interest are aligned from day
one is the key to successful investing.
How to Evaluate Private Real Estate Investments 21
 ABOUT ORIGIN INVESTMENTS

Origin Investments is transforming the way

individuals invest in commercial real estate.
We invest side-by-side with investors, adhere
to a disciplined investment philosophy, and
use technology to make it easy to manage
investments. Origin’s first two funds have
achieved top quartile performance, per
Preqin data. We recently raised over $150
million for Origin Fund III.
Sign up at OriginInvestments.com to
explore our investment opportunities.

A BOU T TH E AU THOR and a year later was introduced to the floors of

the Chicago Mercantile Exchange. He continued
Michael Episcope to work full-time on the trading floor for the
Principal and next 16 years while attending night courses
Co-Founder to complete his undergraduate degree. After
Michael is Origin’s rising from runner to broker, Michael was given
principal, co-chairs an opportunity to become a floor trader by a
the Investment Chicago based hedge fund, Tradelink, LLC, and
Committee and then enjoyed a prolific nine-year trading career.
oversees investor Trader Monthly Magazine named him one of the
relations, marketing top 100 traders in the world twice.
and company
operations. He brings In 2005, with two children and a third on the
25 years of investment and risk management way, Michael cashed in his chips and retired
experience to the company, and believes that from trading. His new focus was in managing
calculated risk-taking in inefficient markets is the the wealth he had accumulated. He enrolled in a
key to building wealth. master’s program in real estate at DePaul and
co-founded Origin Investments two years later
He frequently shares his knowledge with individual with David Scherer.
investors on Origin’s blog, Forbes, ValueWalk and
Huffington Post, and his expertise has made him a Michael is the former president of the DePaul
frequent speaker on real estate investment panels Real Estate Alumni Alliance and a sustaining
and podcasts. sponsor of the DePaul Real Estate Center. He
has been a Vistage member for more than six
Michael learned about the physical aspects of real years and lives in Chicago with his wife and three
estate in his youth as he helped his grandfather children. He enjoys traveling with this family and
manage his apartment buildings on Chicago’s snowboarding, and frequents ski resorts all over
West Side. He began college at DePaul University North America.

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